Cash is king in business. To maintain operations and realize your plans for growth, you must manage your cash flow carefully. Creating a statement of cash flow can help you see where your business stands from a financial standpoint.
But what exactly is a cash flow statement? What does it show and how do you create one?
What is a Cash Flow Statement?
A statement of cash flow is a financial report that outlines cash that has entered and left a business during the reporting period. They provide a more detailed look at where a business’s cash went and from where it was received.
Cash flow statements are important financial statements because they help others understand how the business operates and its value.
What does the cash flow statement show?
A statement of cash flows is generated to show cash inflows and outflows from:
Operating Activities
On a cash flow statement, operating activities refers to any and all sources of cash from business-related activities, including:
- Receipts from sales of services or goods
- Salary/wage payments
- Income tax payments
- Interest payments
- Rent and utility payments
- Payments to suppliers and vendors for goods and services used in operations
- Any other expenses related to operations
Investing Activities
Investing activities include any cash related to the company’s investments, such as:
- Asset purchases or sales
- Loans given or taken out
- Payments relating to mergers and acquisitions
Financing Activities
Financial activities include cash inflows and/or outflows from banks and investors. This can also include:
- Cash paid out to shareholders
- Dividends
- Repayment of loans
- Stock repurchases
Taking a closer look at cash related to operating, investing and financing activities will provide a clearer picture of a company’s financial health and performance.
Why Do You Need a Cash Flow Statement?
Do you really need to create cash flow statements? Yes. Even if your business appears to be profitable on paper, it may not be generating a healthy cash flow to stay afloat and cover its expenses.
Here’s why cash flow statement is important:
It Helps with Short-Term Planning
Cash flow statements are invaluable when making short-term plans. A business must be able to cover its operating expenses, employee wages and other costs to stay in operation.
A cash flow statement provides a detailed look at how much cash a business has on-hand, allowing them to make short-term plans backed by data.
It Provides Insight into Spending
A cash flow statement will provide an overview of expenses that may not appear on profit and loss statements. Loans, for example, are generally not included in a profit and loss statement, but they affect a business’s cash flow.
It Shows the Results of Cash Planning
Many businesses create cash plans to help them reach their goals. However, life and business can often be unpredictable. As a result, there may be times when a business cannot execute its plans or meet the plan’s objectives.
Cash flow statements help businesses determine whether their cash plans were successful or whether they need to make adjustments to get back on track.
Comparing actual and planned cash flow numbers also allows businesses to make more accurate predictions in the future.
It Helps Businesses Focus on Increasing Cash Flow
Cash flow statements provide business owners and stakeholders with a detailed look at the cash that’s coming into and out of the business. Having this data allows decision-makers to focus on effective ways to increase cash flow.
For example, a business may find that it’s spending too much on inventory and optimizing its inventory can help free up more cash.
It Helps with Crisis Management
Cash flow statements allow business owners and stakeholders to see whether a business has a cash shortfall or windfall at any given time. In times of a crisis, the data from a cash flow statement can help with making the right decisions and taking action more quickly.
Long-Term Plans
In addition to short-term plans, cash flow statements can also help businesses make long-term plans. Growth requires careful planning over longer periods of time. Keeping a close eye on cash flow helps businesses make changes when necessary and adjust their plans as needed to ultimately reach their goals.
Essentially, cash flow statements help key decision-makers understand what needs to be prioritized if they are to reach their end goal.
Monitor Working Capital
A business’s working capital is the cash it has on hand to manage its daily, operational expenses. Cash flow statements allow businesses to analyze the movement of their working capital and improve or optimize operations as needed to improve cash flow figures.
Creating A Cash Flow Statement
Now that you understand why a cash flow statement is so important, let’s look at how to create cash flow statement.
We’re going to look at how to create cash flow statement using the direct method:
Calculate Your Operating Activities Cash Flow
To calculate cash flow from operating activities:
- List and add up all of your cash inflows related to your operating activities.
- List and subtract all of your cash outflows related to your operating activities.
The answer is your cash flow from operating activities.
Calculate Investing Activities Cash Flow
Once you have calculated your cash flow from your operating activities, you can focus on your investing activities.
- List and add up all cash inflows related to your investing activities.
- List and subtract all cash outflows related to your investing activities.
It’s important to note that this section should only include investing activities that involve free cash. This means that debt-related activities should be ignored.
Calculate Financing Activities Cash Flow
Finally, you’ll want to calculate the cash flow from your financing activities.
Again, you’ll want to subtract all cash outflows from your cash inflows for these activities. GAAP (generally accepted accounting principles) requires you to include dividends paid in this section.
Find Your Ending Balance
Now that you have your cash flow figures for all three of these sections, it’s time to calculate your ending balance.
Your ending balance is the sum of cash flows from your operating, financing and investing activities.
- If the sum is positive, this indicates positive cash flow. Positive cash flow means that your business is able to meet its obligations and may even have a cash surplus.
- If the sum is negative, this indicates negative cash flow. Negative cash flow means that your business is spending more money than it’s generating. Steps should be taken to return to a positive cash flow situation, or the business may struggle to remain operational.
Once you’ve calculated your cash flow, you can use this data to make better business decisions.
The Limitations of a Cash Flow Statements
It’s important to remember that while a cash flow projection statement is insightful, it does have limitations.
For example, negative cash flow isn’t always cause for alarm. Sometimes, a company’s cash flow may fall into negative territory if it’s recently expanded or made an investment that will lead to future growth.
When creating cash flow statements, it’s important to analyze and review the numbers carefully to determine whether corrective action needs to be taken or if the issue is just a one-time thing.
How is a Cash Flow Statement Different from an Income Statement and Balance Sheet?
Income statements and balance sheets are used to help create cash flow statements. But each of these statements is different in its own ways.
Cash flow statements look at a company’s performance over a specific period of time and it is not as easily influenced by non-cash transactions. It does not include future inbound or outbound cash that has been recorded as an expense or income.
How are Cash Flow Statements Used?
Cash flow statements can be used by investors and key employees of a business. Investors may use cash flow statements to determine whether a business is financially sound and poised for growth or too high of a risk to make an investment. Investors will often use other financial documents (such as balance sheets and profit and loss statements) as well to make their final decision.
Key employees may use cash flow statements to gauge how their department is contributing to a business’s performance and what they need to do to make their performance more impactful. These statements may also be used to help create budgets and make hiring decisions.
Cash flow statements are used by many individuals, and they provide key information on the financial health and performance of a company.
Financial Decision-making
Creating a cash flow statement is important for every business. It provides a more detailed look at a business’s financial performance and health, but it also helps with short-term and long-term cash planning.
A cash flow statement shows whether a business is solvent and growing, or if it is cash-strapped and headed for trouble.
Ultimately, a cash flow statement is a valuable financial statement that provides insight into the profitability and long-term sustainability of a business. Businesses also use cash flow statements to predict future cash flow through forecasting and projections. These predictions help businesses know when to make key decisions, such as hiring, equipment investments, expansion, and more.